I recently spoke to the Middleton Chamber of Commerce on the eurozone crisis. They gave me a generous six minutes to discuss the most complicated financial crisis I’ve analyzed in a long while. I can’t even say hello in six minutes, but I gave it my best.
In a nutshell, here’s what I had to say:
- Substantial levels of leverage (all over the globe).
- Subsidize Greece – piss off hardworking Germans and other prudent Europeans. Let Greece fall – potential domino to Portugal, Italy, Ireland, and Spain as well.
- The developed markets have super high debt, too, but their debt costs are cheap right now. (Who knows for how long, though?)
- Weak global demand. Deflation today, inflationary pressure seems likely to follow.
- Option contract costs have skyrocketed, which means volatility is a mainstay.
- S&P 500 derives 45% to 50% of revenue overseas. If Europe breaks, the U.S. recedes.
- Political distrust in ability to make decisions quickly and correctly. Policymakers are taking over the allocation of capital decisions. Very “risky.”
We’ve never seen this before. Extreme possibilities (both good and bad) are entirely possible. Why? Because everyone knows all of these problems; if they don’t turn out as bad, it’s likely going to be very good for markets.
So in the past month, it appears to be the news the world has been waiting for: a comprehensive plan by Germany and France to back the banks, which from all that I had read, was the only plan the governments could do in order for the Eurocrisis to “at best” work through this reasonably. Who knows whether it has legs, but I’m of the opinion, at this point, that the world knows how serious the Eurocrisis is and is somewhat, if not entirely, ready to step up.
And in a world where we just got through one panic (2007-2009) it is hard for me to appreciate that we should necessarily walk right into another. I think there has to be some reasonable probability in our thinking that policymakers will not repeat the mistakes they made in 2008 and 2009. Sovereign debt is also easier to value than subprime mortgages. And there is much greater clarity about where bad government debt lies and at what rate the good debt can cover it. The solutions to these problems are reasonably understood, although whether the policymakers actually can orchestrate them or not is another issue.
No matter what, though, I also think there has to be some reasonable probability that we’re going to be in for a bumpy ride even with pending solutions. Uncertainty of future actions of political leaders remains.
Beyond Greece is Italy. Beyond Italy are Portugal, Spain, and Ireland. All of these countries have problems to solve. If they get solved, expect markets to love it. If not, well, then I think we’ve seen the results of this over the summer.
When the U.S. faced our crisis, we were one nation, one economy, one inflationary environment, and one essentially focused government. Even with two political parties, we were all focused. We were able to act with relative unity, unleash TARP ($700 billion), and prevented a run on the banks.
Today we are the currency of choice, and TARP may turn out to be a moneymaker for the U.S. government.
Unfortunately for the eurozone, you have 17 nations, 17 economies, 17 inflationary environments, 17×2 political parties. Many countries are influenced heavily by socialism, while the U.S. maintains a strong influence in protecting its interests. So, as I scratch my head here, it seems you have 17 to the 4th power x 2 parties, which equals 167,042 possible arguments. Now you know why this is so hard.
That doesn’t mean stocks will rise or fall dramatically one way or the other …ÃÂ no one knows this, but we have to get used to volatility since the world really has never seen events like this, and so it has to work itself out through the ongoing day-to-day market pricing mechanisms.
Anyway, it’s easy to point out problems. Solutions are rare, but usually helpful. Here are some that I think make sense:
- Recognize that economic theory and investment markets are ever evolving. They were and are designed by mankind; they are not laws of nature, though, and require you to be thoughtful about the marketplace.
- The future is simply too complex to comprehend, while capital markets are possibly the most powerful secular force on the planet. So don’t delude yourself into thinking you can accurately predict the short-term future on a consistent basis. (Or listen to those folks who say they can – they are equally or even more delusional.)
- Rather, think about what you know you can control today (savings, spending, diversification, goals, worldview) and plan accordingly. Mitigate risks and course-correct as necessary. Create a plan that is based on reasonable assumptions.
- Keep working (if you can). Preferably love (or “like a lot”) your work. Human capital will almost always be more valuable than portfolio capital, especially if you love what you do.
- Assess your optimism. Optimism is necessary to grow and invest. If you lack optimism, you lack a foundational component of healthy investment.
- Cycles have been around for 2,000-plus years. They’re not going away. So be ahead of the next one up by staking a place in it.
- Oh, and if the euro drops, it could make traveling overseas cheap again, so enjoy it if you can!
Finally, I recently read the book Future Babble: Why Expert Predictions Are
Next to Worthless, and You Can Do Better. It’s a great read and, considered properly, could actually lower any anxiety you might have about the future by putting the proper perspective in place.
Michael Dubis is a fee-only certified financial planner and president of Michael A. Dubis Financial Planning, LLC. He is also an adjunct lecturer at the University of Wisconsin Business School James A. Graaskamp Center for Real Estate. Mike can be reached at email@example.com.
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